Evaluating Liquidity and Exit Strategies in UPREIT Investments

Upon your successful contribution of a property into an umbrella partnership real estate investment trust (UPREIT), receiving operating partnership (OP) units may feel like the end of the line. You start earning passive income without the burden of active management. However, entering the UPREIT is simply one step of the entire investment process. At some point, you’ll want to liquidate or exit so you can use your capital for other investments or personal use.

There are various UPREIT exit strategies you can try, each offering unique advantages and risks. To help you plan for the best option, Realized 1031 shares an article discussing each avenue and its pros and cons. Let’s take a closer look.

Converting OP Units to Shares and Subsequent Sale

The most common method to liquidate your capital in a UPREIT is by converting the OP units to REIT shares, then trading or selling the latter for cash.

Pros

• The most straightforward method to access cash
• Flexible timing that helps you convert and sell when market conditions are favorable
• You can sell some REIT shares and keep others to maintain exposure in the real estate market.

Cons

• The conversion and sale of the REIT shares are taxable events. You may encounter a major tax hit if the contributed property was highly appreciated.
• REIT share prices can fluctuate, so selling during a downturn may result in lower-than-expected returns.

Selling OP Units Back to the UPREIT or Another Investor

There are a few UPREITs that allow investors to sell back their OP units to the operating partnership or find a private buyer. This option typically involves negotiation and may not be available in all UPREIT structures.

Pros

• The private sale helps you avoid public markets, allowing you to secure a price that isn’t based on current market sentiment.
• Private sales might also allow for more tailored terms and timing.

Cons

• A private sale is still a taxable event, leading to tax liability from the unrecognized capital gains during the 721 exchange.
• Private sales are not always available in many UPREITs.

Holding on to OP Units Until Death

You may opt to keep holding your OP units until your passing. At that point, the units undergo a step-up in basis. The cost basis resets to the asset’s fair market value upon your death, eliminating capital gains and depreciation recapture.

Pros

• Tax relief for your heirs, especially if they convert and sell the REIT shares immediately.
• This strategy can be a great estate planning tool for those who want to pass their wealth easily.
• Investors continue to receive their share of partnership income or distributions throughout their lifetime.

Cons

• Since this strategy forgoes liquidity, it may not be suitable for those who need liquid cash at some point in their lives.
• The value of OP units is still tied to the performance of the underlying real estate portfolio, which can fluctuate over time.

Summing Up: Pros and Cons of UPREIT Liquidity or Exit Strategies

Exiting an UPREIT must be part of the plans of any investor entering one. There are a few options you can try, such as selling the REIT shares, a private sale, or holding the units until death. To choose one that fits your needs, in-depth research, and expert guidance is still key. Plus, your goals might evolve, so knowing which strategy works best for each scenario helps you prepare for any possibility.

Sources:

https://taxfoundation.org/taxedu/glossary/step-up-in-basis/

https://www.hellodata.ai/help-articles/what-is-an-upreit-in-real-estate

https://www.investopedia.com/terms/u/upreit.asp